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Collapse of Argentine Economy
The Collapse of Argentine Economy began in December of 2001 after a failed attempt of transforming the South American economy from socialism to capitalism. Background Following massive hyperinflation in the 1980s, Argentina pegged its peso with the dollar at a 1-for-1 exchange rate and began privatizing its economy, as suggested by the Washington Consenus. Thanks to the pegging and already existing restrictions, Argentina's central bank lost nearly all of its monetary power to change the rate of inflation. Because the government could still borrow to finance deficit spending, IMF economists gave the tactic of outright convertability a short lifespan. However, Argentina's economy expanded rapidly as the money "rolled in" from all over the world, especially Wall Street. Market forces put pressure on the peso to appreciate but the central bank was able to defend the currency. The government continued to borrow as the economy expanded. Argentine governors retained the large latitude they've enjoyed in the past when it came to deficit spending, particularly in the inland areas. Ranchers and lumbermills employed foreign labor (the exchange rate made them very cheap), driving many out of work. One avenue of spending for the government was to employ these displaced people in make-work jobs. No one seem to care, however, as the economy kept expanding. Recession and Collapse With the exception of a 1995 stumble thanks to the Mexican peso crisis, expansion continued unabated until the late 1990s, as debt exceeded 40% of GDP. Argentina recieves warnings from the IMF to restructure labor laws or the Fund will suspend programs. The defaulting of Russia, however, inspires the IMF keep supporting Argentina. The Russian default bumped up the spread between US Treasury bonds and Argentine government debt, but the IMF support brought it back down. However, this was the beginning of a slight upward trend as Brazil devalues its currency, causing trade to slump. Other problems follow: capital flows world-wide decrease as well as a drop in prices for Argentine exports. The result is a vicious cycle: growth slows so interest rates increase, causing growth to slow more. By 2000 the $130 billion debt was "unsustainable. The double-digit interest payments the markets were demanding on new borrowing were substantially in excess of the country's likely growth rate." (Blustein, 82) Simply put, g was no longer greater than r. Twice in 2001, the IMF agrees to lend a total of $22 billion to rescue the economy and restore confidence while the government reduces spending. The debt is now 64% of GDP. By late November, a full-on bank run emerges as people empty their accounts in droves. After the President and Economy Minister resign in light of mass protests, the successors abandon the fixed rate system and offically default on the loans. The peso plumments against the dollar, losing 75% of its value. Banks close and poverty levels leap to above 50% in a matter of months. Explanations There are many potential reasons for the collapse, some internal, some external. There is little agreement. Internally, Argentina had three major sources of scurity: a fixed exchange rate, a strong tendency for government deficit spending and a general disgust for chancing inflation, harming the structure to change when things started looking bad. Some economists note that the pegging was silly as the US and Argentine economy linkage was too forced. Others blame the inability of the central bank to defend the currency and thus confidence in the economy; the system was working for while, after all. Economists also debate fiscal policy; some claim the lawmakers let the deficits grow too large in the 1990s while others blame attempts to satisfy the IMF in the 2000s. Still other economists blame the sudden reversal (a supply shock) of the capital flows. Externally, Wall Street and the IMF were entirly too confident in the economy (especially Wall Street; from the begining the IMF suspected it wouldn't work). Wall Street, however, often blames the IMF for lending money to the country, because it sent a signal things weren't as bad as people thought. Source Blustein, Paul. And The Money Kept Rolling In (And Out) Category:Macroeconomics